Insiders Raise Their Stakes in Digital Generation

 | Dec 19, 2011 | 2:00 PM EST
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This commentary originally appeared on Dec. 19 at 12:00 p.m. EST on Real Money Pro -- the ultimate traders' resource for actionable trade ideas and in-depth market analysis. Click here to learn more.

The down-and-out shares of Digital Generation (DGIT), formerly DG FastChannel, finally got some love from insiders this month after falling to a mere third of the value they were afforded this spring.

Digital Generation provides digital technology services that make it efficient for companies to electronically deliver advertisements, syndicated programs and video news releases to both traditional broadcasters and online. Through both organic growth and acquisitions, Digital Generation is the only global pure-play provider of TV and online advertising technology.

Five insiders bought $365,050 worth of Digital Generation shares at an average price of $12.17 per share earlier this month. That's not a particularly large dollar value for so many insiders buying, but other factors increased the strength of the signal in my scoring paradigm. The fact that four of the five buyers increased their positions significantly with their latest buys was one factor. Another major one was the timing of the purchases in light of the multiple travails that the company has suffered since this spring.

Digital Generation's shares fell severely after both second-quarter and third-quarter financials were released this year. The most recent disappointment was on the bottom line, as acquisitions expenses helped prompt a $0.15 quarterly loss per share vs. expectations for EPS of $0.05.

In a healthy insider trend, execs merely stopped their selling in response to second quarter's gap down in Digital Generation. It was only after falling another 40% in the wake of third quarter's disappointment that the buying finally emerged from the head office. Too often, insiders make knee-jerk purchases after a sudden decline in their shares and are just as often proven premature in their optimism. The fact that execs held off buying Digital Generation's weakness for so long argues that there is a sense of unanimity about the stock's valuation finally reaching a compelling point.

As always, however, a significant insider signal is just the first step for a company to make my buy list. A stock must also have a fundamental investment thesis in which I can believe. In Digital Generation's case, the company's longer-term revenue growth is impressive even when the past two disappointing quarters are taken into account. The company increased sales consistently over the past five years, from $52 million in 2005 to $248 million in 2010. In the third-quarter conference call, management guided for 2011 to generate revenue of between $330 million and $340 million. Analysts are projecting 30%-plus top-line growth again in 2012.

Granted, Digital Generation's recent acquisition spree (most notably of MediaMind in July) means that much of the recent revenue growth has come through acquisitions. But I agree with management's vision of embracing the convergence of TV and the Internet when it comes to ad campaigns, and the acquisitions have been key to amassing the assets necessary for the company to attack the future opportunities convergence will continue to offer. As it is, Internet revenue has already increased from just 7.3% of sales in the first nine months of 2010, to 15.5% of sales so far this year. Another diversity benefit is that 18% of sales in the most recent quarter were made outside the U.S.

The cons of Digital Generation's recent growth-by-acquisition binge, of course, have been the messy income statements that have caused the company's recent demise. Having generated EPS of $1.50 last year, Digital Generation is only expected to earn $0.89 per share this year and $1.33 per share in 2012. Those estimates are also lower by over a third since this summer given the past two quarterly disappointments.

Down by nearly two-thirds since its spring peak, however, the stock appears amply punished for the company's recent transgressions, which makes me comfortable betting that management will now be successful in digesting the recent acquisitions and achieve its synergy goals of cutting $27 million in expenses by the end of 2012. The risk, of course, is that the company (and its newly promoted CEO) will lose focus during this digestion process. Considering the large amount of debt that Digital Generation has taken on to fund its acquisitions, the ramifications of not successfully cutting costs would be major.

There is plenty of competition waiting to take advantage of any stumble by Digital Generation. Google (GOOG), Comcast (CMCSA) and Akamai (AKAM) are only the most prominent of the competitors listed in Digital Generation's filings. But such deep-pocketed competitors have also made the company the subject of buyout rumors in the past -- most recently, this summer, when Goldman Sachs (GS) was said to be retained to shop the company around.

Valuation was said to be the sticking point for any transaction this summer. At this point, however, just getting the $20 for which the shares traded after the second-quarter earnings disappointment would make this position a big winner. This stock has been so beaten down that it could arguably gain several dollars on a technical bounce alone before hitting logical resistance. So beyond the fundamental value I see in this long-term revenue grower, short-term traders trying to play a year-end rally could justify buying into Digital Generation as well.

If I'm fortunate enough to see the shares make such a technical bounce, I'll decide at that time whether to stay for the long term. As of now, however, Digital Generation is a suitable play for both investors and traders.

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